United States

Mass. court holds biotech firm engaged in substantial manufacturing

Required single-sales factor apportionment for corporate excise tax


On January 12, 2017, the Massachusetts Supreme Judicial Court issued its decision in Genentech, Inc. v. Commissioner of Revenue, affirming the Massachusetts Appellate Tax Board’s decision which held that Genentech, Inc. was ineligible for an abatement of approximately $3.3 million in Massachusetts corporate excise tax because it engaged in “substantial manufacturing,” thus requiring the company to apply a single-sales factor apportionment formula. Further, the Court held that the application of the single-sales factor formula did not violate the dormant commerce clause.


Genentech, a California-headquartered company, produces biologically-derived pharmaceutical products. Using a four stage process, Genentech employees modify the genetic codes of living cells to produce "proteins of interest" with desired pharmacologic effects.1Genentech also derives revenue through various investments. On the financial side of its operations, the company invests excess cash in short-term securities -- money market funds, commercial paper, and treasury bonds. Its treasury department conducts daily assessments of its cash needs and liquidate investments for cash, or invest excess cash as necessary.Under Massachusetts corporate excise tax law, a manufacturer must apportion its income using a single-sales factor formula, rather than the standard three-factor formula used by general business corporations. For tax years 1998 to 2003, Genentech filed Massachusetts corporate excise tax returns using the standard three-factor apportionment formula. However, in 2004, the company originally filed its Massachusetts return using the single-sales factor formula applicable to manufacturing corporations, before applying for an abatement for that year, arguing that it was not substantially engaged in manufacturing. The Massachusetts Department of Revenue subsequently issued assessments for tax years 1998 through 2003, taking the position that Genentech was engaged in substantial manufacturing requiring the use of single-sales factor apportionment. The Massachusetts Appellate Tax Board upheld the assessments.

The litigation

Substantial manufacturing

In its appeal to the Massachusetts Supreme Judicial Court, Genentech challenged the commissioner’s determination that the company should be classified as a manufacturer for Massachusetts corporate excise tax purposes.  During the tax years at issue, a "manufacturing corporation" was defined as follows:

“In order to be engaged in manufacturing, the corporation must be engaged, in substantial part, in transforming raw or finished physical materials by hand or machinery, and through human skill and knowledge, into a new product possessing a new name, nature and adapted to a new use.

Genentech contended that its processes should not be considered manufacturing, as they were more akin to mining, rather than the transformation of raw or finished physical materials into a new product. However, in finding that Genentech engages in manufacturing, the court stated that unlike the extraction and crushing of rocks in the cited mining cases, Genentech is not merely paring something down to a smaller size. The court noted that Genentech “implants DNA molecules into a cell” causing a transformation from the natural genetic code. Therefore, each genetically modified and replicated cell is different from the original cell in a fundamental way.

Genentech asserted that even if its pharmaceutical development process was deemed to be manufacturing, it did not qualify as engaging in substantial manufacturing, which is required for the single-sales factor apportionment formula to apply.  Under Massachusetts law, there are five tests for measuring whether a corporation’s manufacturing work is “substantial,” only one of which needed to be met.2The decision noted that both parties agreed the first test (whether 25 percent or more of its total gross receipts, whether inside or outside of Massachusetts, are derived from the sale of manufactured goods that it manufactures) was applicable.

Genentech argued that “gross receipts,” for purposes of the test, should include receipts from all transactions, including its receipts from the redemption or return at maturity of funds invested in short-term securities, which if included, would place the company under the 25 percent threshold. However, the Court stated that if Genentech’s financial transactions are included into gross receipts, the true nature of the company’s operations would be distorted, thus receipts from financial transactions should be excluded for purposes of evaluating whether the company’s manufacturing work is “substantial.”


Genentech also challenged the Massachusetts statute which requires single-sales factor apportionment, as it applies to the company, claiming that the law violates the dormant commerce clause, due to the unavailability certain state tax credits, which are provided to in-state manufactures. The court acknowledged that when the 1995 change in the apportionment formula for manufacturing corporations occurred, it may have caused the amount of income apportioned to Massachusetts to decrease for manufacturing corporations that conducted their manufacturing operations in the Commonwealth, and have had the opposite effect on corporations with out-of-state manufacturing facilities. However, the court stated that “the dormant commerce clause does not forbid a state from changing the allocation formula it uses to determine what share of the income generated by a multistate corporation operating in the taxing state is fairly subject to tax.”

As such, the court disagreed with Genentech’s claim that the law violated the dormant commerce clause, stating that the apportionment formula treats all manufacturers – in-state and out-of-state – equally, thus not discriminating against interstate commerce.

Implications of Genentech

Biotech businesses subject to the Massachusetts corporate excise, with significant property and payroll outside Massachusetts, could see an increase in tax liability when applying the holding in the Genentech decision. The Supreme Judicial Court’s decision may also signal a surge in recharacterizations of out-of-state companies as manufacturers by the Massachusetts Department of Revenue for years open to audit, leading to a potential increase in Massachusetts corporate excise tax liabilities due to the application of single-sales factor apportionment.

The Genentech decision demonstrates that new processes used to develop products in the biotech sector and particularly in drug development, may qualify as manufacturing activities for Massachusetts corporate excise tax purposes. Still, the activity and processes of each company should be analyzed independently, on a case-by-basis. In contrast, life sciences companies having substantial property and payroll in Massachusetts, which are not already classified as manufacturers, should review the broad characterization of what constitutes a manufacturing company for Massachusetts corporate excise tax purposes and inquire into whether it may take advantage of the potential tax benefits.

First, Genentech alters the DNA of the selected cells to instruct them to produce a specific "protein of interest."  Second, it places genetically altered cells in successively larger tanks to facilitate growth.  Third, the protein of interest is purified by separating it from the mix of cells and other material present through ultrafiltration and chromatography.  Finally, following the purification process, Genentech formulates the resulting drug into its final dosage form, for packaging and sale.

2  General Laws c. 63, § 38 (l) (1), provides in relevant part that "a manufacturing corporation's activities will be considered to be substantial if any one of the following five tests are met:1) twenty-five per cent or more of its gross receipts are derived from the sale of manufactured goods that it manufactures; 2) twenty-five per cent or more of its payroll is paid to employees working in its manufacturing operations and fifteen per cent or more of its gross receipts are derived from the sale of manufactured goods that it manufactures; 3) twenty-five per cent or more of its tangible property is used in its manufacturing operations and fifteen per cent or more of its gross receipts are derived from the sale of manufactured goods that it manufactures; 4) thirty-five per cent or more of its tangible property is used in its manufacturing operations; or 5) the corporation's manufacturing activities are deemed substantial under relevant regulations promulgated by the commissioner.


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